Maximizing Gains Vs. Minimizing Losses

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In last Saturday’s post, I talked about the current bear market rally, which struck a hot button with several readers. Ray left an excellent and detailed comment, which I will use as a basis for today’s post since it covers an important area of investing. Here’s a portion of what he said:

Patience is a virtue that has tripped up many an investor, including the author of this note over the years. As you look at monthly charts and see a rally since March 9, all of us wish we were invested to catch some of the explosive upside. Unfortunately, you might as well double down in Vegas, because (as you have written) there is no way of seeing the bottom until it is in and replaced by a solid trend reversal.

Ulli, your work allows us to do exactly that. I have recently checked some of the mutual funds I sold on your last sell signal in June and was not surprise to see some of them down as much as 60% from that sell signal, even with this rally—-you can only imagine how glad I am to miss this past rally for the opportunity to have saved my portfolio. All I need to do is figure how much of a return I would need to break even (if I had not sold them) to keep my hands off the BUY KEY—-But I am still as anxious and impatient as I have even been. I have found that over the years I have been able to make far more money by not loosing it in the bears, and I must give you the credit for allowing me to keep my emotions in check.

This brings up an interesting point. When investing, we all like to maximize our gains and minimize our losses. However, since this can rarely be done on purpose, the question remains whether one could be more important than the other? In other words, over a period of time, is it more critical to maximize your gains or to minimize your losses?

Reader Ray has found that not loosing it during a bear market has made a big difference to him, and I agree with that. To look at some real numbers, let’s review again a table I posted in my free e-book “The SimpleHedge Strategy:”

It shows the annual returns of the S&P; 500 for this century vs. a hedged buy-and-hold strategy, which I don’t advocate but which I have used in this example. As I have mentioned before, when comparing any kind of returns, especially the ones the buy-and-hold crowd publishes, you need to always include a bearish period. Otherwise, you might be misled to conclude that a certain mutual fund or ETF only heads for the skies.

This table clearly shows the good, the bad and the ugly when it comes to returns. If you are trying to maximize your gains, you have to be invested all the time, which will result in your portfolio receiving severe haircuts when the bear strikes. Of course, during years like 2003 and 2006, you’ll be running around pounding your chest by seeing your assets perform so well.

On the other hand, a strategy minimizing your losses clearly has merits when the bear hits hard and you are safely on the sidelines or in a hedged position.

It all comes down to the time frame you use for your evaluation. For example, looking at only one year to evaluate anything is short-sighted and does not give you enough data to base a decision on.

My experience has shown that a conservative strategy, such as trend tracking, which does not necessarily give you the highest returns possible during good times, but avoids the pitfalls of a bear market during sharp corrections, will be far superior over time. The above table, while representing only one period in history, clearly supports that view.

This goes along with a general theme in life in that it’s not how much money you earn, it’s what you keep that matters. It’s the same with investing.

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Comments 3

  1. Ulli,

    One of my three trend timing methods of which all produce nice gains and yours is one of the ones I use. I also really like http://www.mutualfundmagic.com/index-twoforthemoney.html which when back-tested produced a compounded annual growth rate of 17.86% over an 8.52 year period. The date that the back-test was run was on 04-01-09. This confirms what you are saying in the above bloq that one has to avoid the bear and this “Two For The Money” by Al Thomas certainly does that and also uses a bear fund too during sell signals, which is working out quite nicely at this time as it did in the last bear 2000-2003. I must say that your TTI method also avoids the bear manglings and I thank you and appreciate your work. You continue to tell us things that the “Money Manglers” will never tell us because it wouldn’t be in their best interest or at least that is what it appears that they believe. Ever ask a “Money Mangler” if He/She thinks one should sell and move the money to a cash fund or bear fund and see what the answer will be? We all know that the answer will always be something like this: stay the course, you are in for the long term, the market always comes back, you might miss the biggest up days in the future etc. What about the largest down days in the future, you don’t hear much about biggest down days. Yea right 12 years of gains down the tube, how long is the long term anyway especially if you are now 62 years old and had planned to retire, but the retirement account is now down 30-60% from it’s peak and maybe about even from where it was 12 years ago? Buy and hold recommendations by the “Money Manglers” should be a Wall Street crime. Maybe someday in the future they will be required to explain the trend tracking/timing methods out there that have a good track record to their clients so that the are aware that there are methods out there that can help protect them from the bear.

    TrendMan

  2. There is one aspect of that table which I find simply astonishing.

    Looking only at the “Hedged Growth” column, it becomes apparent that at no time in the past decade, despite two severe bear market declines, would the sell button have been pushed on the hedge strategy.

    The hedge never fell by as much as 7%. Amazing.

    Maybe this view does not account for short-term 7% retreats off of market highs but nevertheless it’s a remarkable record for the strategy.

    G.H.

  3. GH,

    To be clear; I never said that the hedge did not go down more than 7% during the years of the study.

    I said that if someone was lazy, held the hedges and rebalanced only once at the end of each year, this would have been the results.
    Given more time, I will track and see what the draw down would have actually been.

    Ulli…

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